Poloz Expects High Debt, Rate Sensitivity to Persist in Canada

(Bloomberg) -- Bank of Canada Governor Stephen Poloz said he expects the nation’s high household debt levels will persist for years, leaving the economy more sensitive than before to interest rate increases.

In a speech Tuesday on how the central bank plans to incorporate large household debt levels into future rate-hike deliberations, Poloz said he needs to worry about the “sheer size” of the debt and will be closely watching the impact of higher borrowing costs on the most vulnerable households.

The Bank of Canada has raised interest rates three times since July, and Poloz reiterated rates are bound to continue rising given the economy is close to its potential. The pace of future hikes, however, will be determined by a number of factors, including questions around U.S. trade policy and Canada’s ability to cope with higher borrowing costs.

The bank “is focused on the vulnerability of our economy to rising interest rates,” Poloz said in Yellowknife, Northwest Territories. “There is little doubt that the economy is more sensitive to higher interest rates today than it was in the past, and that global and domestic interest rates are on the rise.”

The Canadian dollar pared some losses after the speech, and was trading 0.1 percent lower at C$1.2858 per U.S. dollar at 4 p.m. in Toronto. Yields on Canadian government two-year bonds added 2 basis points after the speech, and were up 4 basis points on the day to 1.94 percent.

Hawks and Doves

“Governor Poloz’s remarks today offered something for everyone,” Royce Mendes, an economist at CIBC World Markets Inc., said in a note to investors. “Hawks will latch on to the comments suggesting that the current rate of interest is well below the economy’s neutral rate, and that the central bank has become more confident in the outlook.”

“But doves will focus on comments reiterating that high levels of household debt mean that rate hikes are more powerful this cycle, and that the bank needs to closely monitor the response to higher rates of some of the most vulnerable households in Canada,” Mendes said.

Poloz said it’s a balancing act for policy makers. Raising rates too slowly could fuel inflation and increase financial vulnerabilities as debt mounts. Moving too quickly risks “choking off growth” and “triggering the sort of financial stability risk we are trying to avoid,” he said.

Macroprudential policies -- essentially government regulations to slow the accumulation of debt -- improve the “trade- off,” he said. “As we approach every interest rate decision, we need to consider all the risks the economy is facing relative to our forecast, including those related to household debt,” he said.

While recent steps to tighten mortgage rules were welcome, he added, the measures will only impact new mortgages. “The stock of household debt, including the $1.5 trillion in existing mortgages, will persist,” Poloz said. “And this debt has increasing implications for monetary policy.”

Take Time

Even with that caveat, Poloz reiterated the central bank is becoming more confident that less monetary stimulus will be needed over time.

The governor also reiterated that various forces restraining the economy -- he cited U.S. trade policy, North American Free Trade Agreement negotiations, and competitiveness challenges -- are keeping the policy rate -- currently 1.25 percent -- from rising to its neutral level, which the central bank estimates is between 2.5 percent and 3.5 percent.

“These forces will not last forever,” Poloz said, “As they fade, the need for continued monetary stimulus will also diminish and interest rates will naturally move higher.”

Positive developments will also reduce the need for negative real interest rates, said Poloz, citing the variable as “another benchmark for measuring monetary stimulus.”

“All this to say that we are becoming more confident that the economy will need less monetary stimulus over time,” Poloz said.

Still, it will take time for the central bank to determine how much of an impact the three rate increases July will have on the economy, though the central bank is already seeing evidence higher interest rates are moderating borrowing growth, he said.

©2018 Bloomberg L.P.